Ahead of the Curve

The lending environment is undergoing a worrying change. Funds that European direct lenders have raised but not yet deployed are at an all-time high and banks in most Western-European jurisdictions have renewed lending following years of reticence after the global financial crisis, leading to increased competition amongst lenders in the small and medium enterprise (SME) market.

Africa: the efficient frontier

"Africa is where Asia was 20 years ago," says Richard Segal, a strategist with African financial services firm UBA Capital. "The question is, will Africa be where Asia is now in 20 years' time?" It certainly struggles against many questionable assumptions. First, that it simply isn't relevant as an investment destination: in fact it represents about 2% of global listed market capitalisation.

Second, that it is an economic basket-case: well, even after a series of cuts to the IMF's (perhaps pessimistic) growth forecasts, Africa is still expected to expand by 2% this year (against global shrinkage of -1.2%); moreover, that growth is being achieved against falling inflation (in contrast to the stagflation of the 1990s). Deals done around external debt and sensible management of the commodities boom have seen many African countries build a platform for managing that long-term growth project.

The third assumption is that Africa is a continent of conflict and corruption: while no one would claim things are perfect, the trends are clear - a handful of countries now suffer serious conflict, as opposed to dozens through the 1980s, while 70% now enjoy functioning democracies.

"We are seeing a step-change in governance at national and corporate level," says UBA Capital's global head of research Jonathan Harrison.

Ayo Salami, director of African business research at Duet Asset Management, whose Duet Victoire Africa Index fund has already attracted investment from European pension funds and who also runs an active Duet African Opportunities fund, says that his portfolio companies achieved average annual earnings growth of 25% in Q1 2009. "We certainly aren't seeing the tsunami of profit warnings that we see in the developed economies," he observes.

The debate raging around Dambisa Moyo's book Dead Aid shows that Africa does not yield to simplistic characterisations - whether optimistic or pessimistic.

"You can't take a blanket approach to Africa," as Chris Derksen, head of frontier markets at Investec Asset Management, puts it. "You can't turn around and say things like ‘Aid to Africa is wrong'. You have to be cognisant of the needs of individual regions, countries and businesses."

And this is the most interesting aspect for long-term investors - the fact that Africa really presents a hugely diverse range of super-growth opportunities in a way that other frontier markets do not. "The region isn't dominated by an India, China or Brazil," Segal observes. The Mahgreb is clearly very different from sub-Saharan Africa. But Tunisia is also different from Algeria, Ghana from Nigeria. Triangulate three countries at random and you are likely to get one equity-based economy, one bond-based and one that has yet to achieve either. That opens up the possibility of effective top-down risk management - different sectors in the same country tend to be more correlated than the same sectors across borders.

The timing looks good, too, after last year's indiscriminate scramble for liquidity. The Nigerian and Mauritian indices currently trade on P/Es of about 7.4x and 8.5x respectively, and the West African BRVM and Kenya also look cheap (Ghana, on almost 25x and Morocco, on 17x, look less reasonable). Moreover, as in many frontier markets, listed ‘national champions' applying pricing power in growing markets look especially compelling.

"Businesses in these environments often operate as oligopolists - and we can see that in their margins," says Derksen.

But isn't the point of frontier markets all about growth companies working to poach market share from the big boys? "The entrepreneurial spirit of Africans goes way beyond what we can imagine," enthuses Mohammed Hanif of Africa specialist Insparo Asset Management. There are sectors, like telecoms, where nimble Davids can take on established Goliaths - the 23% fall in annual profits reported by Kenya's Safaricom is testament to pretty brutal competition. On the other hand, Daniel Broby, CIO of specialist asset manager Silk Invest, points to Nigeria's Dangote Sugar, which has 98% of the local market cornered thanks to regulations requiring sugar to be fortified with Vitamin A.

Does that mean taking a long-term view on the up-and-coming names while holding the national champions as they make hay for the next decade? Potentially - but competition can come from big Chinese companies as well as local wannabes. China's influence is mostly benign - bankrolling infrastructure improvements that will benefit local companies - but it is also selling to African businesses and consumers.

"African trade with China is one sided, especially for the non-energy exporters' observes Alia Yousuf, emerging market debt portfolio manager with Standard Asset Management. ‘Even the countries that export energy-related goods import a lot of fast consumer goods from China. A lot of African corporations are struggling to compete with Chinese businesses' economies of scale. China has a strategy for Africa, but does Africa have a strategy for China?"

Global integration raises questions of diversification. If Chinese companies sell into Africa, that may hurt some of your African companies but is unlikely to increase China's correlation with African GDP growth. But if your Chinese companies are investing heavily in Africa's economy, does that make Africa just a leveraged play on China and its demand for commodities?

Less so than you might imagine. As Salami points out, even in Nigeria, where oil accounts for 90% of export revenue, it is only 20% of GDP. Zambia is similarly known for is copper - but again, it accounts for just 22% of GDP. "If past growth was not export-led, why should it be export-vulnerable?" he asks.

"The consumer side is resilient and the mostly overlooked informal economies are immune to what's happening in China," agrees Segal.

Microcredit has attracted institutional investors, helping smaller retailers and the commercial real estate that provides their expanding shelf space. Derksen points to a Ghanaian-Nigerian consumer cyclicals business whose profits are growing by 50% a year, and another fast-moving consumer goods firm selling into Uganda and Kenya: "I'm looking at a number of private equity opportunities, none of which is leveraged against China."

Indeed, given that the proportion of GDP represented on stock exchanges in Africa is only about a third of what it is in developed markets, is the real African opportunity in private, rather than public equity? Investec and Insparo already have unlisted investments; Duet has the capacity to do pre-IPO; and Silk Invest's product pipeline also includes private equity. "The opportunity is immense," as Broby attests. "You see it literally on every corner now."

But the risk profile of pure African private equity may not suit many European pension funds and, in any case, investors need not worry that stock exchanges are stacked up with commodity exporters. If there is a concentration in African indices, it is in financials, which is very much local and retail. Kenya's Equity Bank, with its mobile banking service targeting the unbanked consumer, is a prime example. It is both exposed to the informal economy and helping improve its efficiency. The same applies to mobile phone companies that enable fishermen to source the best price from their choice of harbours, or the rural mechanic to make sure the in-town supplier has the spare part he needs.

In Kenya, brewers offering global brands like Diageo know that there is a vast customer base that cannot yet afford Guinness, but is willing to trade up from ‘home brew' to a modestly-priced branded tipple like East African Breweries' Senator. Even the infrastructure boom, played by many investors through listed cement producers, can be a retail story in Africa, as significant demand comes from homebuilders buying by the sack load with monthly pay cheques.

Portfolios have to be constructed carefully - South Africa, Nigeria and Egypt dominate listed equities, and country-specific risk counts for a lot here - but the listed African story is very much an African story, and not a story of manufacturing or production for a global customer base.